Game Theory Group

The Blockchain Brief

Crypto Hedge Funds vs. Crypto Index Funds

Holy shit, crypto is still green today! That's right mom, crypto is not "dead."

And if that's the case, you should join us on Friday, April 27th at 6:00pm to listen to the biggest YouTuber in crypto sit down with the most successful PR firms in crypto. We will discuss how crypto and traditional media impacts the blockchain industry. Big thanks to Square1 and Localytics for the sponsorship, and to all of the folks at Pillar for making #BostonBlockchainWeek happen. I took the remaining tickets for our event and made them free for subscribers of this newsletter -- use code THEBRIEF to get them free. There's about 20 left. 

Alright, on to today's discussion:

Many in the industry are still talking about the recently announced Coinbase Index Fund. This new fund will give investors exposure to "all digital assets listed on Coinbase’s exchange, GDAX, weighted by market capitalization." At the moment, these assets are Bitcoin, Bitcoin Cash, LiteCoin and Ethereum. This index fund will join Bitwise HOLD 10 Index and the Grayscale Digital Large Cap Fund, immediately becoming a top player in the crypto index game. 

Let's take a step back and define an index fund. In layman's terms, an index fund manager looks at a market (bio, tech, crypto, etc) -- or a subset of a market (big cap crypto, small cap bio, etc) -- and creates a roll-up of the assets within that market. These assets are then traded as a single unit. The idea behind an index fund is that you get broad exposure to a market you believe in, without the stress and risk of picking a single winner. 

I completely understand why Coinbase is making this move. They are holding an enormous amount of crypto already, and can now find a way to generate fees from their holdings and custody expertise. On the flip side, wealthy folks or institutions can now get exposure to the crypto market without dealing with custody, research, rebalancing and keeping up with the news cycle on individual assets. It's a much easier way to tell your golf buddies you own some Bitcoin, while actually remaining a nocoiner. 

The emergence of index funds in crypto will certainly have an impact on the ease with which crypto hedge funds have been raising capital. In the past, hedge funds have been able to raise on the pitch of "exposure" to crypto markets. In exchange for that service, they have been charging hefty fees, sometimes far exceeding the "2 & 20" that traditional funds have mostly used.

I would argue that most of these funds, even the well known ones, are basically just creating a private index fund, one that looks a lot like the HOLD 10 Index, and hodling forever. Sprinkle in some private ICO investments for diversification, and you've got a crypto hedge fund. For comparison, Grayscale charges a 3% management fee, and that's it. I expect that fee to drop over time, eventually mimicking the very low index fund that you see in the traditional finance world.

I did some research on the performance of the Bitwise fund and found some positive news. The index fund outperformed bitcoin’s returns during both good and bad trends in the market.*

December: 78% returns vs. bitcoin's 39%
January: -18% vs bitcoin's -27%

My belief is that the emergence of more traditional financial instruments, like index funds, investment trusts, scalable custody solutions and regulated exchanges will make it increasingly difficult for crypto hedge fund managers to raise funds and generate returns that will validate their fees. Unquestionably, there are innovative thinkers within these funds -- Chris Burniske, Ari Paul, Kyle Samani -- that can build an edge by having unique access and leading insights. If you can invest in those funds and can handle a little additional risk, that's not a bad way to go.

For the rest of us, there's Coinbase.

Boris Revsin